The EU banking reform package has been agreed by European Parliament and is set to come into force by mid-year of 2021. This banking reform package is intended to implement reforms agreed internationally following the 2007-2008 financial crisis to strengthen the banking sector and reduce risks in the banking sector. The package includes Capital Requirements Regulation (CRR) II and Capital Requirements Directive (CRD) V. CRR II also incorporates the changes to market risk proposed by Basel committee in their Fundamental Review of the Trading Book (FRTB).
As the proposals are due to be implemented after the new Investment Firm Regime (IFR) the real impact should only be felt by banks and very large investment firms.
Overview of key elements of package
Leverage ratio requirement:
- There will be a binding 3% ratio of non-risk weighted assets to Tier 1 capital for all institutions in addition to current risk weighted capital requirements.
Net stable funding ratio (NSFR):
- This will be set at 100%. NSFR requires banks to make sure that any exposures are matched with stable funding sources and measures the ratio of available stable funding (ASF) to the required amount of stable funding (RSF) over a one year time period.
- A new market risk framework for reporting purposes has been set. The FRTB set out what level of capital was needed to absorb trading losses but due to time constraints, CRR II has only addressed the reporting requirement.
- The capital elements of FRTB will be implemented at a later point but until then banks will still need to use current CRR for calculating market risk capital.
- Depending on the type of software asset, it won’t necessarily have to be deducted from Tier 1 capital as per current rules. The European Banking Authority will provide more detail on this in due course.
Pillar 2 capital:
- Under CRD V, the current Pillar 2 framework is set to change and makes the distinction between mandatory Pillar 2 add-ons which are more like capital buffers and the supervisory expectation that firms hold capital additional to Pillar 1 – Pillar 2 Guidance.
- Firms will have to meet Pillar 2 capital with at least 75% Tier 1 capital. This is similar to what capital the PRA currently require banks to hold to meet their Pillar 2 capital requirement.
Credit risk / the frameworks have been amended into two key areas:
- Where banks have to make widespread sales of non-performing loans or “massive disposals” this has historically adversely affected the amount of capital they have to hold as models use past data to calculate current capital.
- More favourable treatment is given for pensions and salary backed loans.
- First, smaller, less complex banks will have less onerous disclosure requirements under CRR II, and a review is being carried out to assess the reporting requirements for smaller banks.
- Second, simpler alternatives are being introduced for smaller banks to calculate market risk, NSFR, counterparty credit risk and interest risk in the banking book. A simplified counterparty credit risk will be available to banks with derivatives of less than 10% of the bank’s total assets or €300m.
- There are also simplified obligations on remuneration paid by smaller banks.
- Measures are being introduced to encourage lending to small and medium sized businesses by introducing a new capital discount for investments in infrastructure and raising the threshold where banks can benefit from the reduced risk weighted capital requirement of 75%.
Intermediate holding companies:
- CRD V requires large third-party country institutions with over €40bn of assets (including third party branch assets) to establish an intermediate EU holding company (IPU). This will allow for easier supervision and resolution of EU activities but introduces a new consolidation group requirement for many 3rd party banks.
New measures will also be introduced to enhance the role of prudential supervisors in combating money laundering and terrorist funding.
What’s happening next?
CRD V looks set to come into force by the end of 2020 and CRR II by mid-2021 so banks need to be working on how they will implement the proposals.
In the meantime, BCBS have just agreed an update to their 2016 standard on market risk, which is expected to be in force by 2022. The saga continues…